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Whistleblowers Wanted

The government has decided
that whistleblowers are its friends, and it is
increasingly making efforts to nourish and protect
them. This is evidenced by a provision of the Tax
Relief and Health Care Act of 2006 that increased
potential rewards to people who provide
information on individuals and businesses that
underpay income taxes.

The law, signed on
Dec. 20, 2006, doubled the percentage of a
settlement that can be paid as a reward to
whistleblowers and reduced the government’s
discretion in whether to pay one. The result could
be a much greater incentive for people to alert
the IRS to tax underpayments.

PAYMENTS MANDATORYSection
406 of the act amended IRC section 7623 to
increase rewards to between 15% and 30% of the
collected proceeds (including penalties, interest,
additions to tax and other amounts) where the IRS
pursues an administrative or judicial action
against a taxpayer based on information brought to
its attention by a whistleblower. The percentage
paid is determined by the new Whistleblower Office
of the IRS and depends on the extent to which the
whistleblower’s information substantially
contributed to a collection action. Payments to
whistleblowers in most cases are mandatory, and
whistleblowers have the right to appeal
unsatisfactory IRS award determinations to the Tax
Court. The statute places a 10% cap on awards to
whistleblowers in certain cases where there have
been prior public disclosures of the allegations,
and rewards can be reduced or barred if
whistleblowers planned and initiated the actions
that led to the underpayment.

The new
program is limited to claims against taxpayers
whose gross annual income exceeds $200,000 for an
individual—there is no income floor for
businesses—and whose potential indebtedness for
taxes, penalties and interest is greater than $2
million. Companies and individuals that underpay
taxes and have the whistle blown on them do not
have to be guilty of a criminal violation.

Whistleblowers must report a reward as income
but can take an above-the-line deduction for
attorney’s fees and costs to recover the reward.

PREVIOUS REWARDS LIMITEDSince 1954, the IRS has had statutory
authority to pay rewards, most notably as outlined
in revenue publication 733. Under it,
whistleblowers could seek a reward of up to 15% by
submitting form 211, Application for Reward
for Original Information. The procedure had
limited impact, however, mostly due to its $2
million cap on rewards, the absence of any
provisions allowing whistleblowers to enforce
their claims to rewards and limited promotion of
the program. In the latter half of 2004, the IRS
implemented policy statement 4-27, which increased
the maximum reward to $10 million but did not
resolve the other fundamental limitations. In
another, lesser-known option, select
whistleblowers have contracted with the IRS for a
percentage of recoveries.

EXPONTENIAL INCREASE The
striking feature about most of the new reforms is
that they directly parallel the False Claims Act
(FCA), enforced by the Department of Justice,
which has had tremendous success in attracting
tips regarding fraud in federal government
programs. The FCA permits whistleblowers to file
suits (called qui tams ) on behalf of the
United States against those who defraud the
government and allows whistleblowers to share in
the recoveries. In 1986, Congress amended the
False Claims Act to enhance the incentives for
whistleblowers to file qui tams. Under
the amended FCA, whistleblowers can receive up to
25% to 30% of recoveries (previously 10% to 25%),
depending on whether the United States takes over
prosecution of a case. There is no cap on the
amount that can be recovered, and whistleblowers
have the right to enforce their claims to rewards
in federal district court. The amendments removed
earlier provisions that had weakened the ability
of individuals to collect rewards for information
of which the government had prior knowledge.

Since the FCA was amended in 1986, recoveries
under it from whistleblower cases have been
increasing exponentially (from zero in 1987 to
more than $1.4 billion in 2006). By comparison,
recoveries by the IRS under its whistleblower
program in recent years have not exceeded $100
million annually (including taxes, penalties and
interest).

IMPACT ON TAXPAYERSIt is
anticipated that certain practices will likely
receive immediate scrutiny under the program. Tax
shelters that might previously have gone unnoticed
are far more likely to be discovered, as insiders
begin to see the benefits of blowing the whistle.
Less obviously, publicly traded companies with
internal reserve schedules that outline borderline
tax positions for financial accounting purposes
are likely to see a rash of such schedules used as
road maps for whistleblower claims. The $2 million
threshold of unpaid taxes required for claims will
necessarily focus whistleblower efforts on large
and medium-size businesses and high-net-worth
individuals.

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